TY - JOUR
AU - Caballero,Ricardo J.
AU - Krishnamurthy,Arvind
TI - Global Imbalances and Financial Fragility
JF - National Bureau of Economic Research Working Paper Series
VL - No. 14688
PY - 2009
Y2 - January 2009
DO - 10.3386/w14688
UR - http://www.nber.org/papers/w14688
L1 - http://www.nber.org/papers/w14688.pdf
N1 - Author contact info:
Ricardo J. Caballero
Department of Economics, E52-528
MIT
77 Massachusetts Avenue
Cambridge, MA 02139
Tel: 617/253-0489
Fax: 617/253-6915
E-Mail: caball@mit.edu
Arvind Krishnamurthy
Stanford Graduate School of Business
Stanford University
655 Knight Way
Stanford, CA 94305
E-Mail: akris@stanford.edu
AB - The U.S. is currently engulfed in the most severe financial crisis since the Great Depression. A key structural factor behind this crisis is the large demand for riskless assets from the rest of the world. In this paper we present a model to show how such demand not only triggered a sharp rise in U.S. asset prices, but also exposed the U.S. financial sector to a downturn by concentrating risk onto its balance sheet. In addition to highlighting the role of capital flows in facilitating the securitization boom, our analysis speaks to the broader issue of global imbalances. While in emerging markets the concern with capital flows is in their speculative nature, in the U.S. the risk in capital inflows derives from the opposite concern: capital flows into the U.S. are mostly non-speculative and in search of safety. As a result, the U.S. sells riskless assets to foreigners, and in so doing, it raises the effective leverage of its financial institutions. In other words, as global imbalances rise, the U.S. increasingly specializes in holding its "toxic waste."
ER -